We recognise the importance of ensuring you have robust security in place when granting a commercial lease to a tenant.
The first point of consideration is to determine whether the tenant has the financial ability to pay the rent and to perform the obligations under the lease. This is often referred to as the “covenant strength” of the tenant.
There are various ways to assess the tenant’s covenant strength. You should note whether the tenant is a company or an individual, as this is likely to have a direct impact on your requirements. A few examples could include asking for trade references, bank references, trading accounts and/or bank statements from the tenant as appropriate.
It is important to seek a surveyor’s advice to assist you with determining the appropriate level of security required for your commercial lease. If you deem the tenant’s covenant strength to be inadequate, you may wish to seek a certain level of security for the commercial lease.
We will focus on three possible types of security for your commercial lease:-
Rent Deposit:
You could require the tenant to provide a rent deposit.
The rent deposit could be the sum of between three to six months’ rent paid in advance.
The purpose of a rent deposit is to provide you with a sum of money you can use in the event the tenant defaults on any of their obligations under the lease. A default could include the failure to pay any sums of money due, or a breach of any of the tenant covenants under the lease.
In the event you are required to withdraw any of the deposit, the tenant is usually required to top this up. The rent deposit could therefore prevent court action which could be extremely costly. A point of consideration is whether the tenant has the funds immediately available to provide the rent deposit. A further point to note is that you may find the rent deposit is not sufficient to remedy the default.
Guarantor:
You may wish to require the tenant to provide a guarantor(s).
The purpose of a guarantor is to guarantee the obligations of the tenant in the event of default under the lease.
It is always important to carry out due diligence on a proposed guarantor. You should therefore investigate the covenant strength of the proposed guarantor as well as the tenant. The main question to ask yourself is how effective the guarantor would be in the event of the tenant’s default. The above points also apply to a guarantor when assessing covenant strength.
If your tenant is a company, you could ask for a guarantee from a director (or directors), a parent company or a third-party willing to do so.
An advantage of asking for a personal guarantee rather than a company guarantor is that the safety net of limited liability is removed. A personal guarantee means the guarantor’s personal assets including any property they own could be at risk in the event of the tenant’s default.
Bank Guarantee:
You could consider asking the tenant to provide a bank guarantee as a form of security for your commercial lease, although this is a rare means of security.
The purpose of a bank guarantee is if the tenant defaults under the lease, the bank will be required to pay a certain amount of money to you. The terms will be agreed at the outset.
You should keep in mind that arranging a bank guarantee could be a lengthy process.
If you would like to speak with a member of our Commercial Real Estate team, please do get in touch.
The information provided in this article is provided for general information purposes only, and does not provide definitive advice. It does not amount to legal or other professional advice and so you should not rely on any information contained here as if it were such advice.
Wright Hassall does not accept any responsibility for any loss which may arise from reliance on any information published here. Definitive advice can only be given with full knowledge of all relevant facts. If you need such advice please contact a member of our professional staff.
The information published across our Knowledge Base is correct at the time of going to press.
